Best of 2017: Behavioral Finance and India

Irrationality has an unbreakable sway over most of our thought and decision-making processes.

Yet the study of human behavior and its influence on finance and public policy has attracted limited attention. Richard H. Thaler’s work and 2017 Nobel Prize changed that. Thaler’s conceptual leap was to extend and apply behavioral science principles to public policy.

The elegance of his “Nudge” framework has encouraged government officials to develop behavioral solutions to important public policy problems. In my roundup of the best content of 2017, I focus on Thaler’s standout ideas and the behavioral themes that were most compelling to me this year.

I have one more contribution: A large portion of what I read is focused on India, so I have curated a careful selection of the India-focused content that I enjoyed the most in 2017.

Behavioral Finance

Richard H. Thaler and His Work: This piece charting the emergence and ascent of behavioral economics, from Keynes to Thaler, gives an evolutionary overview of behavioral themes. My favorite Thaler-related story — “Nudging can also be used for dark purposes” — describes how nudging works. The writer gives the simplest explanation of what a “Nudge” is: “If you want people to do the right thing, make it easy.” In addition, the article exposes how policy can be misused to guide the public down the wrong path. Another fascinating episode in Thaler’s career was the dictator games experiments that confirmed the inherent sense of fairness most of us possess and the role rationalizations can play in shaping our actions.

Unlearning and Daniel Kahneman’s Insights: When questioned, we are quick to rationalize our actions. We are often not well aware of our beliefs or how we form them. In an interview, Kahneman revisits the logic behind his conceptions of System 1 and System 2 thinking. But that is just the prelude to what Kahneman wants us to understand: Our beliefs are based on personalized experiences. Conclusions come first and rationalizations come later. Deep-rooted convictions inhibit our decision making and hinder our personal development and organizational progress. Abductive reasoning, as Benjamin Franklin discovered more than 200 years ago, is a well-formed bias that finds explanations to fit available observations. Indeed, a well-known hedge fund rewards its employees for defying authority and actively raising questions.

Hard Cash and Digital Currency: Of all our economic pains, paying for the necessities is the most persistent. But when we make automatic payments, say with a credit card online, as Dan Ariely explains, we don’t feel that pain, which makes saving harder. To better manage our finances, Ariely recommends adopting behavioral hacks — mechanisms that incentivize saving and amplify the pain of paying up.

Behavioral Science and Regulation: Opportunity, rationalization, and the potential for punishment are three critical determinants for policy makers to consider in devising regulations for market behavior. This article draws on Gary Becker and Ariely’s work on building effective governance frameworks.

The Psychological Toll of Our Digital Lives: Digital interfaces have forever changed how we interact with each other. Office-going adults tap their digital devices at a rate of more than 10 times an hour. Social media and smartphones have become necessities for most school-age children. But smartphone use has its dangers and is changing the way younger generations interact. Young people are less social, more isolated, and more prone to mental illness than were their predecessors in the pre-digital age. This is a cause for concern, especially if it’s left unaddressed.

India

IPOS and Mutual Fund Inflows: First the good news: India’s economic growth rate has stayed near the 6% mark. Retail investor inflows into professionally managed mutual funds have been growing at well over 10%. The IPO market is bullish too. With about 160 new listings and US$12 billion in new money, 2017 has been the best year for IPOs in the last 10. Experts caution about a lack of earnings growth, but for now the retail investor’s behavioral weakness — their inclination to go with the flow — is unlikely to change.

The Futility of Market Predictions: The investing bug is bringing in new first-time investors, all eager to strike it rich. But how will the markets fare? Progress may be inevitable but not without volatility. Active managers in India have been articulate about their work. The lack of strategic benchmarks makes performance attribution difficult. But still, India’s growing capital markets may comfort stock pickers about at least earning the risk premium.

India’s Religious Future: Earlier this year, the president of a globally acclaimed financial newspaper asked: What is India’s religious future? I do not know what motivated the question. History suggests that economic progress has more to do with scientific discovery than religious development. The word “religion” used here is probably ritualistic in nature. Perhaps this is the context that the questioner had in mind. But religion has other connotations: for example, taking a religious approach to one’s duty and ethics. This story provides an insightful understanding of financial markets and their relationship with religion as practiced in India.

Agrarian Pain: Throughout the world, farming is a difficult way to earn a living. That is no different in India, where agriculture accounts for about 14% of the nation’s GDP. Farmers in India continue to face a slew of challenges. So far, mechanized agriculture hasn’t met expectations and indebtedness and counterproductive poverty cycles could stall and even reverse India’s economic progress. Perhaps solutions to India’s agricultural woes will develop in the new year.

Banking and Governance: The 2008 financial crisis affected India’s steel, infrastructure, and banking sectors. Misconstrued overcapacity, imprudent lending practices, and misgovernance created an unprecedented pile of bad assets for India’s public sector banks. India’s government has implemented a rehabilitation plan. The question is whether the initiative is sustainable.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.